Palo Alto is a great town.

While there sponsoring IR Magazine’s West Coast Think Tank last week we feasted at Evvia and Fuki Sushi. Denver’s got fine sushi. Our Sushi Den on South Pearl Street flat demoralizes Bryant Park’s Koi. Proprietors Toshi and Yasu Kizaki each day fly in hand-picked selections from the Tokyo fish market. You gotta get up pretty early to beat our fish. Fuki Sushi apparently rises at dawn. We ate to dullness.

Speaking of lulled, exchanges began introducing new SEC-approved Limit-Up/Limit-Down (LULD) single-stock circuit breakers Monday, smartly easing the program into effect. More will be added until the largest 2,000 are covered by late May and the rest of the market through August.

“It sounds simple, but for firms managing thousands of customer orders, you have to program how you’ll manage them, how you’ll deal with quotes and trades across 50 destinations, routing decisions and execution quality,” Chris Concannon, partner at high-frequency trading firm Virtu Financial, told Bloomberg reporter Nina Mehta.

Under LULD, stocks won’t be permitted to trade more than a certain percentage from their rolling five-minute average prices. The SEC mandated these changes after the Flash Crash of May 6, 2010, sent the S&P 500 plunging over a hundred points and the Dow Industrials a thousand points, before both rebounded, all in roughly twenty minutes. Continue reading →

The Great Debate is upon us.

No, not the presidential one tonight. The other one, about equity markets. The SEC’s technology summit yesterday aimed at finding ideas for preventing another Aug 1 Knight Capital debacle from ever happening again included mostly the folks who huddled after the 2010 Flash Crash to prevent glitches from…ever happening again.

Since the Knight glitch came after efforts to prevent glitches from, yes, ever happening again, and since glitches and one-off flash crashes are routine now, reflected in continual halts and erroneous trades (including two yesterday early, even as the SEC summit was commencing), understandably hopes for change are dim.

We’ve gotten many questions in recent days. How do we control technology? Is technology the problem? Are markets too complex?

And the simplest one: Why can’t we shut the hummer down when it goes haywire? Right? Common sense tells us it can’t be too hard if it involves electricity. Pull the plug. Yank the doohickey or whatever out of the machine.

We’ll get a “kill switch,” sure. But HFT won’t end soon because structure depends on it. The major exchanges are averaging about 4.6 billion shares of trading volume, down from over 7 billion daily in 2009, when incidentally Dodd-Frank was crafted. Add 30% more in dark pools and volume is about 6 billion shares each day now.

If we divide that into what’s Navigational – moving stuff around – and what’s Fundamental (real buyers and sellers meeting), it’s about an 85%/15% split. We’re left with 900 million shares of “real” volume, with the rest from HFT, ETF arbitrage, automated market-making and so on. This is the glitch-infested stuff.

What happens if all 85% of it disappears? Nothing, if you’re Berkshire Hathaway’s Class A shares trading 400 shares daily with no navigational volume. For exchanges selling data and services to drive profits, it’s doomsday. The largest broker-dealers would leave equity markets. So would the 50-odd large high-frequency firms. Continue reading →

The structure of equity markets is like Lance Armstrong: Defining an industry but dogged by accusations.

The SEC seems to be in near-continuous investigative mode. Last week the Chicago branch of the nation’s central bank, the Federal Reserve, joined the cooks in the kitchen, including Congress, to huddle over the stove and study the stew.

Speaking of Congress, a bombshell detonated during market testimony last week. Bloomberg’s Nina Mehta wrote Sept 20 in an article titled “NYSE Executive Urges Assessment of 2007 Stock Trading Overhaul” that Joe Mecane, head of equities for the exchange, thinks the SEC should reconsider Regulation National Market System.

You’d expect shock. Thus far, no. But agreeing with Mecane were Nasdaq transaction services head Eric Noll and BATS chief operating officer Chris Isaacson. Rather than piecemeal reactionary remedies to yeasty glitches in trading markets, all three said, regulators should examine the extreme makeover given markets by Regulation National Market System.

SIDEBAR: Join us Friday 9/28 at 3p ET for a web meeting on using Rational Price to sort signal from noise – and to talk about Reg NMS and what issuers should do.

Amid a vast array of market minutia managed by provisions in its 500 pages, Regulation National Market System decreed that trades must meet at the “national best bid or offer.” To facilitate compliance, quotes under Reg NMS are only acknowledged if computerized. Thus, automated quotes have proliferated in continuous footraces to set stock prices. Continue reading →

The equity market is like Bourbon Street.

No, we don’t mean the stock market is home to “Big Daddy’s World Famous Love Acts.” We mean it’s a bit off, a party, somewhat wanton, full of folks in disguise doing things they wouldn’t do anywhere else. Fantastical.

I interviewed Joe Saluzzi at the NIRI Southwest Regional Conference last week in New Orleans. Joe and co-founder Sal Arnuk at Themis Trading are the reason we all know about “high frequency trading.” Their white paper on toxic equity trading went viral in 2008, and the rest is history.

We sat down Charlie-Rose-style at the Hotel Monteleone and talked candidly about Joe’s new book, “Broken Markets: How High Frequency Trading and Predatory Practices on Wall Street Are Destroying Investor Confidence.”

If you haven’t done so, buy it for yourself (I have it on my Kindle) and get a copy for your CFO or CEO. Everybody who at some time utters the word “equity” should read it.

If you’re in the IR chair, executives expect you to deliver a story to investors that advances shareholder value. You want a market that supports those efforts by helping risk-taking capital connect to the opportunity in your shares. Most executives generally conclude that it’s working. Stocks seem to be trading comparably to historical S&P 500 earnings multiples.

So why would Joe and Sal argue that markets are broken? Continue reading →

If our stock reverts to the mean, I don’t see that high-frequency trading matters.

I’m paraphrasing what many CEOs and CFOs believe. The market is complicated. There’s volatility. Trading is global. ETFs and derivatives probably affect volume. But I’m trading at a reasonable multiple of forward earnings, so who cares?

I hear that question sometimes. More often, reporters tell me they hear it from CEOs and CFOs. What difference does it make that 60% of my volume is the same shares trading over and over? So we had 7,800 public companies in the Wilshire 5000 in 1997 and now there are 3,600 in it. My stock trades at 16 times earnings. That’s about right.

So long as my house goes up in value, what do I care that people are getting these really ridiculous variable-rate, no-money-down mortgages for 125% of the home’s value, which means they’re financing the furniture over 30 years? What difference does it make to me? My house is still up 15% in value.

According to the ETF Industry Association, at July 2012 there were 1,486 exchange-traded products (ETPs), up from zero about 15 years ago, give or take, and fast approaching one ETP for every two stocks. The industry had net July inflows of $17.1 billion, mostly to equity ETFs. Continue reading →